Investment thesis on Chubb Limited
A great insurance company at a moderate discount.
I hope everyone had a wonderful Christmas and enjoyed your time with friends and family! We only have a few days left for 2024 and assuming no crazy changes in the market these last few days, it will be another record year. As we head into 2025, it’s even more important that we are properly diversified in our portfolios and in that spirit, I wanted to share this particular investment thesis.
In the last few Investment thesis posts, we’ve looked at opportunities in the Healthcare and Energy sectors. In this post, I wanted to share my thoughts on Chubb (CB), an insurance company within the Financial sector. I started paying attention to Chubb when Warren Buffett himself started taking a stake in it in 2023. Now, we don’t necessarily have to agree with every investment Buffett makes. In fact, some of the investments he makes can’t even be replicated by retail investors because of specific favorable terms he receives. However, Warren Buffet is well know to be an expert in insurance companies having publicly commented numerous times that he believes they are an easy to understand business. Furthermore, Berkshire Hathaway itself is also an insurance company and one of Buffett’s best investments was to purchase GEICO, an auto insurance company. So in this case, it’s definitely worth paying extra attention.
An overview of Chubb Limited (CB)
Chubb Limited is a global insurance company that provides a wide range of insurance products including property and casualty (P&C), accident, and health insurance, life insurance, and reinsurance. They operate all over the globe in 54 countries and territories and service both corporations and individuals providing good diversification against any isolated catastrophes although the bulk of their premiums are still derived from the United States (57% as of 2023 annual report). Their CEO Evan Greenberg has been CEO for the last 20 years since May 2004 providing great stability for the company leadership. I recently watched a CNBC ‘Mad Money’ interview with him about the insurance market and it’s really clear that he has an excellent understanding of the business and is extremely disciplined in his philosophy with underwriting which is the underpinning to how Chubb has grown to where it is today.
The company does a fairly thorough job of breaking down the source of their premiums by both Geographic Region and Product which I include below for reference.
To be honest though, I have neither the in depth industry knowledge nor think it’s worthwhile to invest the time to understand this level of detail for insurance. Instead, I prefer to use a more simple construct for my understanding of the insurance business:
Collect premiums. +$$$
Pay out for claims over time. -$$
At the end of the insured term, hopefully the company has money left over $.
The key here is to accurately model the aggregate risk so that you charge enough to have money left but not so much that you lose business to competitors, a process referred to as underwriting. This is the job for the actuaries and the intricacies involve doing this appropriately for every client so that you can remain competitive.
Imagine if the company did not model risk well and overcharged for risk in some cases but undercharged in others. In that case, the overcharged customers would switch to a competitor company leaving only those that were undercharged. At the end of the insurance term, the company would lose money since they were left with all the customers that were undercharged for their level of risk. This actually brings us to one of the most important statistics in insurance, the combined coverage ratio which is represented as:
where a combined ratio under 100% implies the insurance company is making money from their underwriting. The combined ratio is also what makes Chubb Limited particularly attractive as an insurance company. As we can see from their shared underwriting results, their risk models are excellent and consistently outperform their peers.
Taking a step back, this idea of consistently achieving <100% in combined ratio is actually kind of wild to me. Imagine a traditional bank. When I put my money in the bank, the bank pays me for the privilege of being able to use my money to invest. This is either with interest or services like free checking, etc. However, with Chubb, the customer is giving them their money to invest and paying Chubb for the privilege instead! Of course, this is under the assumption they can consistently make money on the underwriting process keeping the combined ratio under 100% which they have been able to do consistently the last 2 decades.
Valuation of Chubb Limited(CB)
Insurance companies are a bit hard to value using DCF or P/E growth metrics because the consistency of cash flow and net income are a bit hard to predict so we also add a price to book valuation method to this section. We assume a very modest 4% growth in all the projects below but note that this is highly conservative. As shared in the 2023 annual report, premium growth far exceeds this across all segments and all regions (especially Asia). However, I kept this rate low simply due to the uncertainties implicit the DCF valuation method here.
DCF method: Looking at the annual FCF at CB since their merger in 2016 with ACE Limited, annual free cash flow has actually increased fairly consistently. Of note, since CB does not report CapEx separately, these are actually operating cash flows assuming 0 capex so we could subtract a small amount of 100-200 million to account for CapEx expenditure. In addition, the operating cash flow of Q1-Q3 for 2024 (not shown here) has also been increasing compared to 2023. Since management has not stated any clear headwinds for the coming year and has instead emphasized the rapid growth in Asia,
I think we can conservatively use a FCF estimate of 12.5 billion for next year and also assuming:
9% discount rate
Consistent and Longterm growth rate: 4% which is very conservative given history
suggests a fair stock price of $532.67.
P/E method: In the TTM, CB reported $24.43 EPS. Assuming again a modest growth rate of 4% and an industry PE average of 12 suggests a fair stock price of $304.89.
P/B method: The current book value per share of CB is $163.16. Assuming an industry median P/B of 1.5 as fair suggests a fair stock price of $244.74
Overall Valuation: Averaging the 3 methods of valuation suggests a fair market price of $360.77 per share which is decent discount compared to the current market price of $273.16 as of 12/19/2024
Rationale for investment in Chubb Limited(CB)
We have outlined many of the key areas that make Chubb a great company including management and leadership, disciplined underwriting, and diversification and growth across regions. One additional point to note is the company’s return on equity (ROE) has been steadily improving and has now approached 15%.
I have started actively trying to highlight risks in these investment thesis. In the case of CB, I see 3 risks worth bringing up:
Management succession plan. Their CEO, Evan Greenberg is 69 years old now and has been running the company for 2 decades. Changing to new management will always carry risks if the company prioritizes growth over disciplined underwriting. However, I think the culture is well established and this is relatively low risk.
Investment in China. Chubb recently made significant investments into China and has become the first foreign majority owner of a major Chinese financial services holding company, Huatai. This has both potentially really great benefits and it’s own inherent risks dependent on the Chinese government.
Global Climate change. Investment companies are heavily dependent on the risk models built via collected data. However, as we run into unprecedent changes in the climate, it becomes harder to predict catastrophic events such as COVID-19. This could lead to enormous unplanned losses. This last risk is probably the greatest of the 3 mentioned here.
In summary, I assess the overall investment thesis for Chubb Limited as a great company at a moderate discount. It should provide both sector diversification and stable long term growth in my portfolio for years to come and should be reasonable to accumulate until the fair price of $360 per share.
Disclaimer: Any information contained here is not intended as, and shall not be understood or construed as, financial advice. I am not a financial advisor and this is only a documentation of my personal investment journey and decisions. You should always do your own research before making any final decision on investments.